Sometimes our mind can play behavioral investing tricks on us and cause us to make suboptimal financial decisions.
Dr. Daniel Crosby is one of the country's leading authorities on behavioral investing. He joins the show today to discuss some of the key learnings from his new book, The Laws of Wealth. We review some of the rules of behavioral self-management and cover some key ideas to remember so we can all make sound financial decisions.
One of the most important things we do at Keen Wealth Advisors is educating and helping our clients and listeners to be engaged in the planning process. I believe in lifetime learning, and that’s why we reached out to Dr. Crosby and asked him to be on the show to discuss behavioral investing. We like to collaborate with the best of the best, find out what's working and bring those ideas to our clients through our podcast and our meetings.
As Dr. Crosby said on the podcast, "Behavioral finance tries to account for the messiness of imperfect human decision-making and amend it to make it a little bit closer to perfect."
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Insights On Behavioral Investing
1. In every market--up, down, or sideways--you have to focus on controlling what matters most.
Dr. Crosby said, "Over the last 20 years, the market has returned an average of 8-1/4%, but the average investor has kept only about 4%, which barely keeps up with inflation. We give a lot of this back by making fearful, greedy, panicked decisions. I think what the industry is coming around to but needs to now disseminate to the investing public is that the choices you make have just as much or more to do with your ability to reach your goals as do things like the returns you get." Not letting your emotions rule your decision-making is a key to closing the gap between investMENT returns and investOR returns. It helps us reduce behavioral investing mistakes.
2. The research is pretty unequivocal that one of the greatest values that an advisor has is that he or she keeps you from making a handful of bad decisions over the course of your investment lifetime and keeps you in your seat.
In his book, Dr. Crosby cited research that found people who work with advisors do 2% to 3% better per year than those who go it alone. He said, "That 2% to 3% per year comes not from genius stock-picking typically but from just keeping you from being your own worst enemy." It's about consistency. It's about avoiding behavioral investing mistakes. It's about planning and being able to stay the course. I like to say to my clients that one of the best investment processes or programs you can be involved in is one you can stick to.
3. Trouble is opportunity is something that everyone knows but few people do, because the way that we evaluate risk has a lot to do with our mood.
One of the most common sayings on Wall Street is, "buy low and sell high." Intuitively, we all understand this concept, yet in March 2009, at the bottom of that bear market, how many people were stepping in to buy stocks? Having a contrarian mindset can be very powerful, according to Dr Crosby. He went on to say, "There's a huge, huge gap between what we know and what we do, and that’s where I think the advisor comes in. They're able to objectively give you a sense of where we are and what we ought to be doing."
4. Over confidence can lead to bad financial decisions.
As a human species, we are over-confident by and large, and if you're not, you're probably depressed. Dr. Crosby said, "Over-confidence is damaging in a couple of ways, but mostly because it makes us a stranger to our rules. Everyone thinks they're better looking, a better driver, funnier, and so on, and this carries over to our investing lives. Now it's funny to laugh about this stuff in the context of driving or looks or whatever, but when it comes to investing, this can cause us to under-diversify. It can cause us to hang on sometimes to concentrated holdings in our company stock or maybe others that we inherited and have some sort of emotional connection to. This leads us to make decisions that we wouldn’t recommend to other people because our human tendency is to delegate the dangerous and to own the optimistic. We tend to under-represent the likelihood of something bad or tragic happening to us and over-represent the likelihood of good things happening to us. It leads us to make low probability, overly high conviction decisions, and it can be very dangerous."
This is one of the reasons why my wife and I sit down with the advisors here at my own firm and we walk through the financial planning process, the checklist and the investments, what we're trying to accomplish, and the "why" behind our plan. We do this every year with them, commit to them, and are held accountable by them to what we said we wanted.
5. Your life is your best benchmark.
Most people look at the S&P 500 index and benchmark their returns against it. Dr. Crosby said, "People want the kind of returns they’ve gotten from the S&P 500 over the last 7-8 years, but they don’t want what the S&P 500 gave you in 2008-2009, and most people don’t look at that fairly. One reason is you have to understand what you're going for and measure your risk accordingly. The second reason is having a personalized benchmark that connects to your "why.'"
Dr. Crosby added, "Having that personal benchmark from a practical standpoint gets us invested wisely and in a way that we can tolerate, but there's a behavioral component to it, too, that can really animate our saving and our ability to stay the course."
Bill Keen on behavioral investing mistakes...
I've seen many people over the years that have been referred into our firm who have previously been jumping around from investment to investment over their lifetime.
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Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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